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As at least the first phase of the OECD's BEPS project1 wound down with the October release of
the "final" BEPS deliverables, questions remained regarding how much
of the recommended changes would be implemented in the United States in the
near term. Because many of the recommendations require legislative changes or
incorporation into income tax treaties, it may be thought that the impact of
the OECD's recommendations may be somewhat muted in the United States, at least
initially, as the changes would take some time to implement. However, a number
of actions from Treasury and the IRS in recent months indicate that the impact
of the changes resulting from the BEPS project may be coming sooner than
expected.

Proposed Revisions to the U.S. Model Income Tax Convention

The first such action came on May 20, when Treasury released for
public comment draft updates to the U.S. Model Tax Convention on Income (the
"U.S. Model"), which is the baseline text used by Treasury when it
negotiates tax treaties. In releasing the draft provisions, Treasury sought to
address, among other issues, issues arising from so-called "special tax
regimes," which provide for low rates of taxation in certain countries
with respect to mobile income, such as royalties and interest. Treasury
stressed its concern that taxpayers can easily shift such income across the
globe through deductible payments that can erode the U.S. tax base. Consequently, consistent with the BEPS
project, the draft proposals are intended to avoid instances of "double
non-taxation," where a taxpayer utilizes provisions in the tax treaty,
combined with special tax regimes, to pay no or very low tax in treaty partner
countries.

In order to do so, Treasury proposes to deny treaty benefits for
interest, royalties, or other income that benefit from a "special"
tax regime in the recipient's country of residence. This restriction is aimed
at related-party income that is deductible in one country and taxed at
preferential effective tax rates in the other country.

Under the proposal, a special tax regime would be defined as any
legislation, regulation, or administrative practice (such as a tax ruling
provided to a taxpayer by a government) that provides a preferential effective
rate of tax to the tested income, including reductions in the tax rate or the
tax base, unless an exception applies. Exceptions would include regimes that do
not disproportionately benefit interest, royalties, or other income; regimes
regarding royalties that satisfy a substantial activity requirement; regimes
that implement the principles of the treaty's business profits or associated
enterprises article (e.g., Advance Pricing Agreements); certain nonprofit
exemptions; certain pension and retirement benefit exemptions; regimes aimed at
certain collective investment vehicles; and any regime designated by an
agreement of the Contracting States.

A number of comments pointed out that the proposal could potentially
inhibit Congress from enacting any rules that a foreign tax official might
consider to be a special tax regime, since the result would be for U.S.
taxpayers to be assessed with additional foreign taxes. It also could have the
effect of discouraging outbound trade and investment by denying treaty benefits
where the United States chooses to reduce its effective tax rate on
foreign-source income, and could discourage inbound trade and investment by
denying treaty benefits where a treaty partner chooses to reduce its effective
tax rate on U.S.-source income.2

In proposing changes to the U.S. Model, Treasury stated that
treaties exist to eliminate double taxation, not to facilitate "double
non-taxation," and that the tax regimes of U.S. treaty partners are more
likely to change over time than has occurred previously, and that these changes
may encourage base erosion and profit shifting by multinationals. In order to
address these concerns, the proposed changes would also provide treaty partners
the right to partially terminate a treaty for benefits under the dividends,
interest, royalty, and other income articles if there has been a substantial
reduction in the normal rate of taxation in either country after the treaty has
entered into effect. Treaty partners could partially terminate a treaty if one
treaty partner reduced its corporate income tax rate below 15% for
substantially all income of a corporate resident, or exempted substantially all
offshore income from tax.

Comment letters received on this proposal noted that its effect
would be to limit tax competition and to compel a certain minimum level of
foreign taxation, which is not an appropriate goal of tax treaties.
Additionally, the proposed changes allow a reduction in the tax base to trigger
a partial termination, which would create additional uncertainty in determining
whether and how to make cross-border investments.3

Changes to the Procedures for Filing a Competent Authority
Request

These tax treaty proposals are obviously driven by the same sort of
concerns animating the BEPS project. However, because these are just proposals
to change the U.S. Model, and have not yet appeared in any treaties that have
been negotiated and ratified, it may appear that it would take some time for
them to be actually implemented. However, Rev. Proc. 2015-40 (the New CA
Procedure), issued by the IRS on August 12, giving guidance on obtaining
assistance under U.S. tax treaties from the U.S. Competent Authority, has
already incorporated new restrictions on discretionary grants of treaty
benefits, based on similar BEPS concerns.

The Limitation on Benefits (LOB) article of U.S. tax treaties
typically recognizes that the objective tests in the article may
inappropriately deny treaty benefits in certain limited circumstances.
Therefore, a discretionary grant of treaty benefits provision provides a
"safety-valve" for a person that has not established that it meets
one of the other more objective tests, but for which the allowance of treaty
benefits would not give rise to abuse or otherwise be contrary to the purposes
of the treaty. Under this provision,
such a person may be granted treaty benefits if the Competent Authority of the
source country determines that the establishment, acquisition, or maintenance
of such resident and the conduct of its operations did not have the obtaining
of benefits under the treaty as one of its principal purposes.

The New CA Procedure, however, does not include the standard
expressly stated in virtually all LOB articles (not having a principal purpose
of obtaining benefits under the treaty), and instead adds (or substitutes?) a
requirement that the applicant have a substantial non-tax nexus to the treaty
country, and that, if benefits are granted, neither the applicant nor its
direct or indirect owners will use the treaty in a manner inconsistent with its
purposes. The New CA Procedure also provides that the U.S. Competent Authority
typically will not exercise his discretion to grant benefits where the
applicant is subject to a "special tax regime" in its country of
residence with respect to the class of income for which benefits are sought, or
where no or minimal tax would be imposed on the item of income in both the
country of residence of the applicant and the country of source, taking into
account both domestic law and the treaty provision ("double non-taxation").

Consequently, it appears that, rather than waiting for treaties to
be renegotiated to include the May 20 proposed changes to the U.S. Model, the
IRS has already implemented some of the changes through the New CA Procedure.
Written comments expressed concerns that this may amount to a unilateral treaty
override by the United States.4

Transparency and Disclosure – Country-by-Country Reporting

In addition to treaty changes to implement BEPS
recommendations, the United States also has recently taken action to move
towards implementation of country-by-country reporting, which falls under
Action 13 of the BEPS Action Plan and is part of the OECD's push for increased
transparency and disclosure. On July 31, Treasury and the IRS released their
2015-2016 Priority Guidance Plan, listing projects they consider to be
priorities and on which they will be actively working during the period July
2015-June 2016. One of the projects listed in the Plan is: Regulations under
§§6011 and 6038 relating to the country-by-country reporting of income,
earnings, taxes paid, and certain economic activity for transfer pricing risk
assessment.

Substantive Changes to the Section 482 Transfer Pricing
Regulations

Finally, the United States has moved recently to make substantive
changes to its transfer pricing regulations under §482. First, on August 6 the IRS issued Notice
2015-54 (the Notice), announcing its intention to issue regulations limiting
deferral of gain on contributions to partnerships with related foreign partners
and also addressing valuation of controlled transactions involving
partnerships. The new regulations under §482 will apply transfer pricing
methods applicable to cost sharing arrangements (CSAs) under Reg. §1.482-7 to
controlled transactions involving partnerships.

In particular, the Notice announced that the regulations will
provide specified methods for these partnership transactions that are based on
the methods specified for cost-sharing "platform contribution transactions."
Currently, the valuation methods outlined in the cost-sharing regulations are
only considered to be "specified methods" for transactions that are
part of a CSA, and are only available as "unspecified methods" in
evaluating non-cost-sharing transactions.

In addition to incorporating the specified methods from the
cost-sharing regulations to evaluate transactions involving related-party
partnerships, the Notice also announced that new regulations will include
periodic adjustment rules based on those from the cost-sharing regulations.
Consequently, periodic adjustments will be applicable to transactions involving
related-party partnerships when there is a significant divergence of actual
returns from projected returns. These
adjustments will mirror those set forth in the cost-sharing regulations (rather
than the general periodic adjustment rules in Reg. §1.482-4).

Secondly, on September 14, Treasury and the IRS issued temporary
regulations under §482 (the Temporary Regulations) (along with proposed regulations
under §367) that would, among other things, provide for aggregate valuation of
interrelated transactions that are covered in part by §482 and in part by other
Code sections (such as §367). The Temporary Regulations aim to
"clarify" Reg. §1.482-1(f)(2)(i)(A), which provides that the combined
effect of two or more separate transactions may be considered if they are so
interrelated that an aggregate analysis provides the most reliable measure of
an arm's-length result. The Temporary Regulations provide that arm's-length
compensation must be consistent with, and must account for all of, the value
provided between the parties in a controlled transaction, without regard to the
form or character of the transaction.
The Temporary Regulations also note that consideration of the combined
effect of two or more transactions may be appropriate to determine whether the
overall compensation is consistent with the value provided, including any
synergies among items and services provided.

The requirement that arm's-length compensation be consistent with
the "value" provided in a transaction between related parties may
create confusion, however, because the definition of "value" may be
different from the price charged in an arm's-length transaction. Similarly, the
"clarification" of when an aggregate analysis is appropriate depends
on subjective tests that may be susceptible to differing interpretations, like
determining whether transactions are "interrelated" or
"economically interrelated," and whether "synergies" are present. In practice, this may lead to increased
assertions that one-sided transfer pricing methods are less reliable than a
method (such as the income method) based on a discounted cash flow analysis.
Note, however, that the use of subjective terminology and greater use of
aggregation mirror the proposals set forth in the work of the OECD to revise
the guidance on use of the profit split method as part of its BEPS project.5

Viewed as a whole, then, actions taken within the past several
months indicate that Treasury and the IRS are actively seeking to implement
some of the changes being recommended by the OECD as part of its BEPS Action
Plan. The scope of the changes involving treaty policy and the transfer pricing
rules indicate that taxpayers should be prepared for some fundamental changes
to historical tax standards. And the fact that the §482 regulations were issued
in temporary form and the provisions in the New CA Procedure for discretionary
grant of treaty benefits deviate from the text of existing treaties indicates
that the changes may come quickly, and with limited opportunity for public
comment.

This commentary also appears in the November 2015 issue of the Tax Management International Journal. For
more information, in the Tax Management Portfolios, see Maruca and Warner, 886
T.M., Transfer Pricing: The Code, the Regulations, and Selected Case Law, Cole,
Kawano, and Schlaman, 940 T.M., U.S. Income Tax Treaties — U.S. Competent
Authority Functions and Procedures, Chip, Culbertson, and Maruca, 6936 T.M.,
Transfer Pricing: OECD Transfer Pricing Guidelines, and in Tax Practice
Series, see ¶3600, Section 482 — Allocations of Income and Deductions Between
Related Taxpayers.

1 It appears that the
release in October of final reports under the BEPS Action Plan is not the end
of the BEPS project, as the G20 has requested a second phase of the project
from the OECD concerning implementation and monitoring. The focus will be on
implementation of the final BEPS recommendations in domestic laws and in bilateral
and multilateral tax treaties, as well as monitoring of the application of
agreed minimum standards. SeeOfficials
Look to Next Steps to Halt International Tax Avoidance, 24 Transfer Pricing
Rep. 322 (July 23, 2015).

5See BEPS Action
10: Discussion Draft on the Use of Profit Splits in the Context of Global Value
Chains (available at
http://www.oecd.org/ctp/transfer-pricing/discussion-draft-action-10-profit-splits-global-value-chains.pdf)
(Dec. 16, 2014), ¶ 7:In particular, where there is significant integration
involving parties to a specific transaction or transactions within that value
chain, for example in the effective sharing of key functions and risks, the
reliability of one-sided methods may be reduced. One-sided methods may not be
able to account reliably for the interdependence of the key functions and
risks, or for the synergies and benefits created by such integration. In such
cases transactional profit split methods may be an appropriate means of
determining an arm's-length outcome, which takes into account the specific
contributions of the parties to value creation.

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